At times I will go through bankruptcy opinions by our local bankruptcy Judges so you can see what is going on at the trial court level in our bankruptcy courts. Bankruptcy cases like this one are very instructive because they outline the elements of a claim and the burden on the parties to provide evidence and what cases the court is looking at in framing the case.
Judge Somers recent opinion here offers real lessons about evaluating whether or not the actions of a debtor rise to the level of fraud. In this case the debtor, Mrs. Giles, and her husband had a business together and at some point borrowed money from their friends, the Motes, to operate the business. The loan was secured by a mortgage that was never recorded. There was a second loan made more than a year later from the Motes as well.
The debtor and her husband sold the property that secured the loan about six months after the loan was made. The debtor’s husband died in 2018. By this time the debtor was severely in debt to friends and family and a bankruptcy was filed in 2019. The Motes objected to the discharge of the debt to them alleging that there was fraud on the part of the debtor under USC 532(a)(2)(A).
The court goes on to explain that the statute not only includes fraud made through representation but also includes actual fraud made without a false representation. The court broke down the separate claims of fraud dealing with the false representation claim first.
In trying to except a debt from discharge based on a false representation the party seeking the discharge bears the burden by a preponderance of evidence to show that the 1) debtor made a false representation 2) the debtor intended to deceive the creditor 3) the creditor relied on the debtor’s conduct 4) the creditor’s reliance was justifiable and 5) the creditor was damaged as a proximate result.
Judge Somers found that Mrs. Giles never made a false representation. It was in fact her deceased husband that was alleged to have made the representations to the Motes. Since Mrs. Giles never made a representation there was no false state by the Debtor.
The court also looked at the statement made by the now deceased Mr. Giles and pointed out that it was a statement about the repayment of the loan out of the proceeds of a lawsuit. Even if Mr. Giles had made the statement knowing it was incorrect how could it have given rise to the making of the first loan. This was not the reason for the denial of finding a false representation, but the court is pointing out that even assuming a statement is knowingly fraudulently made does not mean that you will get beyond the problems of having to show that the creditor relied on the debtor’s statement and the reliance was justifiable.
Next the court dealt with the nondischargeability based on actual fraud. The party seeking the exception from discharge must show 1) fraudulent intent 2) a fraudulent scheme and 3) injury caused by the scheme.
The court points out that the totality of the circumstances must be considered to determine if there is deceptive conduct by the debtor which indicates an intent to deceive the creditor. The court found that none of the evidence here supported such a finding. The Motes argued that the debtor was insolvent when the money was borrowed but offered no evidence of the insolvency and no clear evidence about the purpose of the loans. The sale of the encumbered land with the unrecorded mortgage occurred after the loan was made and that action had nothing to do with the making of the loan.
All the evidence in this case seemed to indicate that although the debtor was involved in the business as a bookkeeper all the major decisions had been made by the now deceased Mr. Giles. The actions by Mr. Giles were not enough to attribute the to the debtor. There was no evidence the debtor’s behavior was fraudulent.
The elements here are missing in both accusations and the court denied the nondischargeability claim. I think there are always lessons to be had in reading these cases. Much of this is guesswork but if you are a practitioner you see some of these things over and over again.
First and foremost the burden to prove a case usually falls on the party that filed the action. The first claim of fraud by false representation was a non-starter simply because Mrs. Giles did not make a representation at all. It is not just that there was no evidence presented but that there was no evidence at all. As for the actual fraud claim the burden fell on the Motes to provide proof that it was more likely than not that Mrs. Giles had committed actual fraud. This may not seem like a high hurdle but in many of these cases you run into a surprising lack of evidence.
Often attorneys do not have the necessary witnesses or evidence to bring to court. Loans like this are done years before the case is filed and they are often private deals between somewhat sophisticated but normal people. No one involved here is actually a banker or loan officer by trade. Documentation can be spotty at best and the witnesses are often only the parties who have to rely on their all to human memories. And to top it all off you have to show intent on the part of the debtor to prove actual fraud.
These cases can be difficult to prove even when the burden of proof is more likely than not. As an attorney you often have to advise your clients that you do not know what the witnesses will testify to or how believable they will be until the day you get to court. There is little that can be done to impeach someone when they are honest and truthful and comes across as such during their testimony. If the only real evidence is the testimony of the parties and two people disagree on the facts at hand and the court finds that both of them are truthful, then it probably stands that the party that bears the burden of proving the case will lose. The court will find them both the be credible and honest but to simply disagree as to what happened.
Here the court found the testimony of Mrs. Giles to be credible and honest. The court pointed out that both sides had a story to tell that was not exactly the same but the court did not assume anyone was not being truthful. Attorneys defending these actions need to assess the standards required by the party initiating the adversary and the credibility of their client. A case like this calls out for substantial preparation of the witness for what types of questions they will be asked and making sure they have reviewed the facts in their minds before the trial.
Another consideration in this matter is the ability to collect from the debtor. The court mentioned that she was living in an apartment and working at a daycare. Looking at her schedules the only other source of income she has is her social security. It appeared that a bank had liens on all of her real estate and the bankruptcy trustee in the case declined to pursue any assets in the case. This was a chapter 7 case filed in Wichita and the threshold to pursue assets is usually a few thousand dollars or less in some cases.
Even if the creditor had been successful in having their debt declared nondischargeable I believe as a practical matter there never would have been any substantial recovery. Mrs. Giles might have been forced into another bankruptcy afterwards if she had lost on this issue, but I don’t think there would have been anything paid to the Motes beyond a token amount when you compare the available income to the amount of money owed.
I refer to these as pound of flesh cases. The creditor has every right to pursue the case but even if they win the recovery is unlikely. The most they can hope to do is continue to put pressure on the debtor in civil proceedings at the state court. I do not think that as a practical matter much would ever have been recovered according the schedules filed in the case and the report of no distribution by the chapter 7 trustee.